Feeling The Burn

Awareness by the public of escalating gasoline prices in the United States has renewed political interest in alternative sources of energy, like biofuels, and re-energized the debate about what should be done. It is true that increased production of biofuels, such as corn ethanol and biodiesel, in the United States has contributed to inflated commodity prices and prices for fertilizer, animal feed and food. At the same time, environmental concerns and related legislation have increased demand for biofuels. Specifically, legislative mandates in several states require a phase-out of MBTE (the fuel additive methyl tertiary-butyl ether) used in motor gasoline and demand for ethanol is increasing, as ethanol is being used in its place.

On a worldwide basis, although the percentage of biofuels being used is small when compared to fossil fuels, the amount of biofuels used is significant. Biofuels now account for less than 2 percent of liquid transport fuels, but they contribute an equivalent of 1 million barrels per day to world supplies. And biofuels are now being used to supply 30 percent of increased transportation fuels demand. Currently, in the United States, corn ethanol is meeting 99 percent of biofuels needs.

In recognizing the need for increasing the United States’ use of renewable fuels, in late 2007 Congress approved the Energy Independence and Securities Act (EISA). Among other provisions, the EISA established "Renewable Fuels Standards" with a mandate for having 36 billion gallons per year of renewable fuels produced in the United States in 15 years. But U.S. Department of Energy’s Energy Information Agency predicts that current corn ethanol production of 9 billion gallons per year cannot be increased above 15 billion gallons, and it will take 10 years to reach that level. The 21 billion gallon shortfall built into the mandate by 2022 is expected to be filled from second generation cellulosic biofuels, 16 billion gallons of which is expected to be in the form of cellulosic ethanol. In a March 17, 2008, article appearing in the Oil and Gas Journal (OGJ), it was argued that EISA’s mandate would in all likelihood not be met as it presumes that the private sector will invest $80 billion over the next 15 years to build an equivalent of 291 large ethanol plants that would be needed to meet the 16 billion gallon per year cellulosic ethanol mandate.

In a follow up article to appear in OGJ’s June 2, 2008, issue, a case is made for having the pulp and paper industry participate in cellulosic ethanol plant projects, using untapped wood scrap as the feedstock. The article presents the reasons why the pulp and paper industry is in the best position to exploit the ethanol potential of wood debris. It also addresses the many reasons why the pulp and paper industry has not widely embraced the idea of making wood debris into

One of the major concerns is that second generation biofuels produced from wood debris remain relatively costly. However, in the May 1, 2008, edition of Renewable Energy World, in an article titled, "Biofuels: the Good, the Bad and the Unusual," Dr. Ralph Sims of the International Energy Agency (IEA) concluded that "…major deployment of commercially viable second generation biofuels (technology) may be just a few years off." This is consistent with our own findings in a study we undertook for a proposed cellulosic ethanol plant, where two such technology providers had processes that were being successfully built to commercial scale. In this article, the case being made for having pulp and paper mills consider participation in wood-debris-to-ethanol projects is based on what was learned in this study.

Our firm had previously been engaged in evaluating biofuels project proposals and performing due diligence reviews of business plans being used to obtain funding. In almost every biofuels engagement in which we were involved, we found that these projects all had fatal flaws that could not easily be remedied in a timely way. As a consequence, we undertook an initiative to develop a biofuels project that could prove to be technically and financially viable. Our basic research indicated that we should concentrate our efforts in defining wood debris to ethanol projects and concentrate our efforts in the Southeast, to attract participation from among the many pulp and paper mills that operate in this region.

The following arguments were presented to interest mill managers in this region and ultimately, mill owners:

The presentation of these arguments was instrumental in getting the go-ahead from one mill manager to conduct a pre-feasibility study. This study was to provide sufficient information for determining whether participation in a cellulosic ethanol project could generate a high enough "value stream" to be of interest mill owners. The study was also to consider whether it would be financially feasible for the mill to obtain a sufficient share of project cash flows with little up-front investment. This was a tall order, but we agreed to conduct the study.

It was then agreed that this pre-feasibility study provide information and analysis to demonstrate that:

The major finding of this study was the indication that a new significant value stream could be generated for the host mill, if the proposed project were undertaken. A number of prerequisites justify considering this project.

After reviewing the various technologies that offered promise for processing scrap wood, a dialogue commenced with a technology provider that had successfully demonstrated this capability and was willing to license its process. A confidentiality agreement was entered into, and proprietary data was obtained for use in the feasibility study. This data was based on metrics of a specific plant that was under construction. Included were plant construction costs and the construction time-line, plant-operating costs, staffing requirements, steam and power requirements, and estimated ethanol yields from cellulosic wastes having a specified cellulose content. The data obtained from the technology provider was then scaled to reflect three plant sizes.

Data was also developed for each plant size to reflect partial integration of the plant to the host mill. Mill engineers provided estimates of amounts of steam the mill could supply the plant. A plant site was identified on land available at the mill. Estimated infrastructure upgrades were identified and cost estimates made.

Lease values were then placed on acreage to be used by the plant. Cost estimates were made for process steam, electricity and water to be supplied to the plant. Fair value estimates were made for support services that the mill would provide, including waste treatment and disposal, wood waste procurement and materials storage and handling.

Using this data, a financial model was developed and projections run for each plant size. Sensitivity tests were performed using a variety of expected ethanol prices, and costs and yields for various mixes of wood debris and wood chips.

To meet the mill manager’s requirement to minimize the mill’s investment, it was estimated that up-front capital outlays for infrastructure improvements to support the partial integration would cost approximately $1 million. It was also estimated that the "value" of the partial integration support to be provided by the mill would run between $1.1 million per year for a small plant, $2.1 million for a medium-sized plant and $5.1 million for a large plant. It was envisioned that the mill would forgo collection of partial integration support costs for five years in return for equity in the ethanol plant. In this way, the goal of minimizing up-front investment could be achieved.

The study of ethanol pricing indicated that in recent years, ethanol prices were highly correlated to gasoline prices staying in a range of plus-or-minus 35 cents per gallon of observed gasoline prices. It was also found that over a three-year period, although ethanol prices had varied widely, they had been trending upward and that the upward trend is expected to continue, in light of the MBTE phase-out and to increases in gasoline prices. Although a recent average rack price for ethanol was at $2.33 per gallon, a lower ethanol price of $2.23 was used in evaluating the economies of scale for the three ethanol plant sizes.